Not corporations. Oh sure, maybe someone employed by a corporation has to write out a cheque to the order of the Receiver-General, and the cheque may even have a corporate logo on it. But corporations do not pay taxes - people do. The question is which people. Or, in the language of public economics, what is the incidence of corporate taxes?
It is typically the case that those who advocate increasing corporate taxes intend for them to be paid by the owners of capital. The analysis goes as follows: Corporate taxes are applied to profits, and since profits are distributed to their owners, corporate taxes are borne by capitalists.
But that’s far from being the end of the story, at least, not in a small open economy such as Canada. The rate of return on investment is determined by the world supply of savings and the world demand for capital, and since Canada has only a small share of the world capital markets, what happens here has essentially no effect on that world rate of return. If an investment project in Canada can’t generate that rate of return, there are any number of others that can.
Suppose that world rate of return in 9% a year (I’m picking number out of the air here so that the math works out nicely), and that the Canadian corporate income tax rate is 40%. Investors would therefore require that a Canadian corporation generate a pre-tax profit rate of 15%, so that the after-tax return is 9%. Now suppose that the tax rate goes to 50%. Since investors can always get a 9% rate of return on the world market, the only way a Canadian investment project can survive is if it generates pre-tax profits at a rate of 18%, so that the after-tax rate matches the world rate. If it can’t, investors will simply shut it down and move their capital elsewhere.
So how can firms increase their pre-tax profit rates? They can
- raise prices in order to pass the tax increase onto consumers, or
- cut costs – notably wages and/or employment, or
Who pays for corporate taxes? Not owners of capital, even if they were the original target – they still get the world rate of return. The people who really pay are consumers and workers.
Since 2000, Canadian corporate tax rates have fallen by over 8% - how does this compare with other countries? Here are the main rich countries' corporate tax rates, graphed against the openness of their respective economies (measured as the average of exports and imports as a percent of GDP):
It would appear that the other rich countries' policy-makers have learned this lesson: countries that are more open have found that they are obliged to keep corporate taxes low, while those that are less open can have higher rates. Moreover, the three countries with the highest taxes also have the largest economies.
How does Canada compare? According to that graph,
- All countries that have similar levels of openness have significantly lower corporate tax rates.
- The only countries with higher rates are the United States, Japan and Germany: all much bigger and less open to trade than Canada.
Despite the recent cuts, Canadian corporate tax rates are still pretty high.